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Woodstock for Capitalists is about to overtake Omaha this weekend, and I thought it was only appropriate to post about a company with a Berkshire tie-in. The company in this post falls into the same realm as Mills Music Trust, a simple concept where nuances make a big difference.

The trust

The trust in question is Kiewit Royalty Trust (KIRY). The name might seem familiar with readers who know Berkshire's history, Kiewit is the name of the building Berkshire has their headquarters in. Kiewit Royalty Trust falls in the same category as a lot of little companies I look at, they're easy and quick to analyze, their annual report filed in March is only 14 pages long.

The trust is simple, they own leases or lease interests in four coal mines located in the Powder River Basin area of Wyoming and Montana. Since Berkshire is a theme of this post it's only appropriate to mention that over 90% of Burlington Northern's coal originates from the Powder River Basin. I would presume something similar for Union Pacific the other large western railroad.

The trust is a pass through entity, all of the royalty money from the coal mines gets sent straight off to shareholders. The trust doesn't have any assets other than cash waiting to be sent to shareholders, and their only liability is trustee fees to US Bank, and audit fees which are nominal.

Investment merits

Buying a share in this trust is really a bet on the American coal industry. An industry that's isn't exactly a hot investment right now. Incidentally before I did this post I read this article in Bloomberg talking about coal's future in the US. The pivot point for this investment rests on the distribution which was $.19/sh in 2011, $.23 in 2010, and $.25 in 2009. If you start to look back at their previous 10-Ks it becomes apparently quickly that tons mined per year has been in steady decline. To further compound this is coal pricing has been weak at best. The following graph is from the above linked Bloomberg article.

Pricing for Powder River coal is off 45% over the past year which in turn has hurt shareholders of the trust. The potential for an investment here is two-fold, the first is the current yield is 13%, the second is that if the price of coal recovers the trust's distributions per unit should increase. Of course the opposite is possible as well, coal could continue to be replaced by natural gas, and the commodity price continues to decline. One stat from the article I found really fascinating was that in 2008 Southern Co generated 70% of their electricity from coal, it's now down to 32%.

The Berkshire connection

I mentioned above that 90% of Burlington Northern's coal comes from the basin that Kiewit has leases on. The second and more interesting connection is that Kiewit Royalty Trust's largest shareholder is Walter Scott Jr. Scott is a friend of Buffett's from years ago and sits on the board of Berkshire Hathaway. Walter Scott is also chairman of Level 3 communications of which Fairfax financial (the Berkshire of the north?) owns a large stake. I searched The Snowball for references to Walter Scott and found six, there's another dozen references to Kiewit plaza as well. Most of the Walter Scott references were stories about Warren going out on his boat, or Scott building a large house with the proceeds from his Berkshire investment (note, not his coal royalty trust investment!)

Summary

There really isn't much to say about Kiewit Royalty Trust. As coal is dug out of the ground and sold on the spot market the money is sent off to investors. The current yield seems attractive but the prospect of further coal price declines, and declining coal usage in the US casts a cloud on the stability of payments. If history is any guide they will continue to decline unless prices make a strong recovery.

"It isn’t exactly cheap. But it’s a good value." - Walter Schloss

For all the fear in Europe I'm finding good value, but not screaming bargains. My dream is finding companies like Precia selling for less than NCAV, but the only place that exists right now is Japan. Instead of once in a life time bargains the European situation is making good companies cheap, Precia Molen is one of those. This company almost forced itself upon me, I received some comments and emails praising it after my post on Gévelot, it appeared on the list of comparables for Gévelot, a list Geoff Gannon created, and a trusted investing friend recommended I look at it, how could I not?

What they do

The easiest way to describe Precia is that they enable customers to weigh things. They build scales and scale systems that range from small scales a laboratory might use to a scale system used at a truck weight station. The scales I find most fascinating are their continuous scales. A scale of this sort is installed onto a manufacturing assembly and will constantly evaluate volume or product weight.

A distinction I feel I need to make about their product is it's geared toward high usage applications. They don't just make scales that people use to weigh things, they make scales that are integral in a customer's process. In a manufacturing setting if a scale is broken a machine won't know when to stop filling packaging. If a scale breaks in a lab researchers won't be able to conduct experiments. I don't say this to mean that Precia has a moat, I don't think they have any sort of competitive advantage at all. But I want to point this out because their product is a necessity. A client will find a way to replace their product if it breaks, they can't defer replacement until times get better. This is important because scales that are used often will eventually wear out no matter how well built they are.

Why invest?

I want to try to get back to the idea that a suitable investment thesis can fit on the back of a napkin, and present that with each post. Here is my stab at a napkin thesis for Precia Molen:

A company that's been consistently growing profits the past ten years while steadily growing book value deserves to trade above book value with a P/E higher than 7.8 and a EV/EBIT higher than 3.6x.

Additional factors:

43% of the market cap is composed of cash.

Debt is 21% of equity and interest is covered 38 times.

The company pays a growing dividend, past six years growth rate is 11.2%

Earnings growth rate for the past 10 years is 17.9%

ROIC of 17.12% and ROE of 13.4%

Expanding into India, Morocco, Brazil and Romania.

Management repurchased shares

Earnings power

Most of my thesis rests on Precia's earning power, a company with their earnings power and growth shouldn't be trading at the level they are. The question I first asked was is their business under pressure such that earnings are about to drop off a cliff? The answer to this question comes from the company themselves, here's what they said:

The macro outlook is cloudy in Europe, but Precia believes that 2012 should be similar based on current demand. This could obviously change at any time, but this is better than what Gévelot's management said, they said they were feeling the pressure and doing their best to react.

I put together a little spreadsheet showing earnings, earnings per share, and the growth rate for the past ten years.

The reason I did this was I wanted to see if a slowdown in earnings growth was leading to their undervaluation. Often a company that is consistently growing will be punished by the market when growth slows. I think this spreadsheet shows pretty well that while earnings have grown solidly it hasn't been a straight line, and each year hasn't blown out the last like Apple does. The results have been lumpy, but lumpy in the right direction.

One thing that always makes a deep value person like myself nervous when looking at a company like Precia is I want to see where the cash is going. Are shareholders being rewarded by purchasing and holding onto this company? I created two graphs to show that I believe that's the case with Precia.

The first graph shows the equity value per share growth since 2006:

This graph shows the cumulative growth per share in assets, dividends and intangibles:

Risks

A lot of the reason this company is cheap is it happens to be located in the wrong spot, in Europe where business is set to seize up and everyone will be living on the streets soon (well at least if you read US media). Looking beyond the hype there are a lot of headwinds facing companies over there, reduced demand, and increased financing costs to name two. I really thought this over for Precia, how will this company fare? Will I be looking back in two years wishing I would have just had cash and avoided the investment?

I took a step away from the headlines and thought about Precia's business and clients. I have no reason to believe Precia's scales are of anything other than average quality. The fact remains they're used often and they're high volume products. Putting something heavy on top of a scale day after day will eventually wear the scale out no matter how well it's manufactured. If these scales are integral to client processes the clients will be forced to upgrade no matter what the financial situation is. They might pressure Precia to reduce their prices, but they will eventually need to upgrade their scale. If not through Precia through a competitor. Based on my experience with manufacturing companies if they have someone build out a system for them in almost all cases they will have that same company service it, and if the system lasts they'll have the same company replace it as well.

I should mention here the company isn't immune, they took a write down in the beginning of 2011 over their Irish operations. The goodwill impairment was small around €300,000, but they were still impacted.

Final Thoughts

I read a fair amount about Precia, read through their annual report and looked back at their history asking myself "why shouldn't I invest?" I couldn't come up with a good reason. This isn't the cheapest investment I've ever found, but if the company executes in the future in a similar manner to how they have in the past I think this is a very good value buying almost exactly at book value. I was initially disappointed that I wasn't finding quality net-net and cheap book value stocks in Europe. Then I realized that if I fill out a portion of my portfolio with companies like Precia Molen at very reasonable valuations I will do fine over time. This isn't the sort of investment that's going to return 75% in the next year, but I think in five or ten years I'm going to be very satisfied.

One number, sometimes that's all an investment revolves around, just one single number. Sure other things need to be considered and weighted, but everything hangs in the balance on that one solitary number. Get the number wrong and the investment fails, get the number right and even with other errors things will still work in your favor. Not many investments can be condensed down to a specific number, Aztec Land and Cattle company can.

Aztec Land and Cattle is a simple company, they own land, lots of ranch land in Arizona, 228,040 acres to be exact. The company started back around the time of the civil war acquiring a million acres of land in for the price of 50¢ an acre. Through the years the land was ranched and parcels sold off until Aztec was left with its current 228,040 acres around the area of Snowflake AZ.

The land is currently used for cattle grazing generating a modest income for the company. The company has financial statements which they make available to shareholders, but those don't matter all that much to this investment, what really matters, the one number that matters is what is that land worth?

Most people have a quick negative reaction when hearing Arizona, land and value in the same sentence. But the question should be framed differently, "Is ranch land in Arizona really only worth $49 an acre?" I'm no expert, but $49/acre seems awfully cheap, unreasonably cheap. And when I see something unreasonably cheap my ears perk up..

If Aztec was content leasing out their land for grazing and never intended to do anything with the land this investment wouldn't really be that interesting. What makes it interesting is that the company has put together a plan to actually monetize the asset. The plan is hosted on their website, but not wanting to crush their server I also uploaded the PDF to Google (it's 158megs!). Aztec built out a comprehensive development plan for both residential and commercial usage. What makes this even more interesting is that due to the size of the land holding they were able to get their plan approved as the official county development plan. What this means is that over the next 30 years as development takes place in Navajo County AZ the development will take place as Aztec has planned it. This has already begun when the state referenced the plan to determine the placement of new roads in the county.

Another aspect that makes Aztec interesting, besides the gross acreage the company also owns water rights under their land. The water on Aztec's land includes a few high quality groundwater reserves without detectable drawdown. This in addition to the numerous streams that also run through the property.

A second aspect that could make Aztec some money is that a portion of their land is being considered for a wind farm. If the wind farm is approved and built Aztec will receive lease revenue from the windmills. There's a section in the comprehensive plan that discusses this for the curious.

The water and wind are both potential catalysts, but the reality is this whole investment rests on the value of the land.

So what is that land worth?

Aztec's land could be the highest quality land in the world but if they don't have a way to monetize it there isn't much value for shareholders. I did some Googling of local real estate firms near Snowflake AZ looking for raw land zoned for residential and got a range of current values for residentially zoned raw land. I found acreage prices ranging from just over $1000 an acre up to $2700 an acre. I'm sure someone will stop reading here and calculate $2700 * 228,040 = $615m against a $11.1m market cap, think this is a slam dunk and put in a market order, don't do it, keep reading.

Another way to look at Aztec's value is how do they value it themselves? In their thin annual report they mention they sold 7,102 acres to their subsidiary for $461,677 which works out to $65 an acre a full 30% higher than the current market price.

What we need to think about is that while Aztec's land could eventually have a significantly higher value per acre it's at some point during the next 30 years. The value of the company ultimately rests on how much of their plan is executed and when it's executed.

I put together a small spreadsheet outlining some scenarios to show what a potential value for Aztec could be depending on when development begins, and how much of the plan is ultimately executed over the next 30 years. Think of this spreadsheet as educated wild guessing.

I used $1000 an acre as my base value and adjusted it up for inflation. I didn't adjust the price up each year, my BAII plus can't quite handle that and I'm not looking for precision, just ranges. The time to develop is the length of time between now and whenever development begins. I think the most reasonable is that development won't start for another 10 years or so and maybe 50% of Aztec's plan is executed. If that happens this company is worth at least double, my suspicion is that the land will eventually sell for more than $1000 an acre, and even if it takes 10 years for the plots to begin the asset conversion process.

So is this a buy?

I really don't know to be honest. It seems unreasonably cheap at $49/acre, but based on my spreadsheet a lot depends on how long, how much, and for how much. This company intrigues me to no end, it's a chance to own a bit of the wild west stapled to a lottery ticket based on Arizona's eventual growth. If nothing else Aztec Land and Cattle is for patient investors, if you have the ability to hold this for 5, 10 or 15 years I have almost no doubt you'll do well. This is the sort of investment that rewards those with a long time horizon, and the ability to see out past the present negative Arizona sentiment.

More Information
Ticker: AZLCZ
Website: http://www.azteclandco.com/ (there is nothing there except for a picture and a link to the PDF)

I want to start this post with a small discussion on how I've begun to look at stocks that sell below book value and have what I'd consider average earnings power. Obviously not all companies can be valued through the same lens, but I think there are a lot of these 'two pillar' stocks out there right now. With the lack of net-net's outside of Japan, and not many actual high quality companies selling at multiples I'd consider cheap I've found myself looking at a lot of these two pillar stocks.

Two pillars of value

Long time readers will recognize that the stocks I look at fall mostly into two different buckets, the irrationally cheap (things like net-net's), and average to decent businesses selling at low valuations (cheap hidden champions for example). Throw in a few special situations and that basically summarizes most of my investments, and not incidentally most posts on the blog. I've long recognized that there's a "hole" in my style but I couldn't quite identify it or make sense of it.

The hole is what to do with an average business that's selling below book value and has decent earnings but is really nothing stellar. The answer was found in chapter 38 of the 1951 edition of Security Analysis. I want to say thanks to the reader who has pointed me in the right direction on this. This chapter was instrumental to Graham, Schloss and Cundill's investment styles. The reader who mentioned this to me is quite successful using this style, and I'm hoping to integrate it myself.

The idea is there are two pillars of value, book value and earnings power. The investor wants those two values to support each other. So for example consider a company with a book value of $10 a share that's also earning $1 per share. With a conservative multiple on earnings such as 10 or 12x the earning power $10-12 a share supports book value. What we're basically saying is since earnings is in support of or slightly in excess of the company's book value there is no reason for the stock to trade below book value. So in the case of our example if the stock was trading at $5 it's reasonable to think they should be worth $10.

Onto Gévelot...

The best way to describe the two pillar style of asset/earning investing is to use an example. I'm going to use Gévelot, a company that I found using the FT.com screener.

The company consists of a parent company with three wholey owned European subsidiaries. The business segments of the subsidiaries are cold extrusion, fluid technology and automotive parts such as motorcycle carburetors. Both the extrusion and mechanical division make parts for the automotive industry, the fluid subsidiary supplies parts for a variety of industries such as oil and gas.

For anyone wondering extrusion is a process of ramming metal through a die to change its shape. Gévelot specializes in cold extrusion meaning this process is done at room temperature to minimize oxidation of the metal. The company's website has some nice descriptions of the business segments in English, and I got lost on Wikipedia reading about extrusion. I worked at a metal stamping factory one summer during college so the extrusion stuff took me back a bit to that dark, greasy factory on the shores of Lake Erie...

The parent company owns office space which it leases out to the subsidiary companies. Dividends are paid out of the revenue received from rental income. The subsidiaries don't pay any dividends up to the parent level.

The business segment breakdown of revenue has been as follows:

Pillar one, book value

I mentioned above that there are two pillars of value supporting intrinsic value. Buying when these pillars agree and well below their agreed on value gives the investor a margin of safety. The first pillar comes from the balance sheet; book value.

Due to the lack of an easy recent balance sheet for Gévelot I build out my own:

There are a few things I want to highlight, the first is that working capital is very close to the current market cap for Gévelot. The company isn't a net-net, but they are trading very close to working capital. The second item is that debt to equity is reasonable at 31%. European companies tend to be more levered than their American counterparts. Even still 31% is very manageable.

The last item of note is that equity is composed of very little goodwill or intangibles. This is an important point, one of the keys to this investment is the strength of book value. If book value was composed mostly of goodwill we wouldn't have as much safety in buying below book value. As it stands Gévelot's balance sheet is composed of quality current assets, and hard assets such as manufacturing facilities.

The company's equity value is €127m, this is against a market cap of €51m a sizable discount.

Pillar two, earnings power

Gévelot is immediately enticing if you look their ticker up on any stock stat page, they have a P/E of 4.7 and a EV/EBITDA ratio of 1.7. I wanted to go a step further than just grabbing a few stats from Bloomberg.

If we take the company's earnings from the last year or two and slap a 10x multiple on them they easily equal book value. So in a simple sense we have both pillars that match, the earnings power, and the book value. I didn't want to just take a gamble and use the last year's earnings so I built out a small spreadsheet showing the operating and net earnings over the past six years. I also tossed in cash flow and free cash flow over the past five since the 2011 annual report hasn't been approved yet.

When looking at this my biggest concern is that Gévelot's margins are at an all time high and will eventually drift lower. The good news is that they're a consistent cash generating company, even in 2009 when they had a loss. Some readers will note they aren't a free cash flow machine, which is expected for such a capital intensive business. Gévelot needs to continually reinvest in their company to keep up their earnings power.

Putting it all together

The big question after looking at each pillar independently is do they work together to establish a valuation? I think they do, the following table shows how earnings power and book value are both similar numbers:

Even the low end of the range, the average earning power over the last six years is greater than the current market price. At a minimum Gévelot is worth 23% more than, and at most it's worth 178% more. I think the company is worth more than the minimum but less than the maximum which puts it in the range of €120m or so. With a possible value around €120m and a trading price at €51m I'm giving myself a pretty large margin of safety to be wrong. If it turns out that Gévelot is only worth €80m I still end up with a 56% gain which would be acceptable.

I haven't put in an order for Gévelot yet because I want to hear your thoughts, and I'm considering waiting for the 2011 annual report to be finalized. So the question I'm asking myself is...

I introduced Hanover Foods last week as part 1 of a two part series on the company. In the first post I gave a background of the company and some investment highlights. My goal in this post is to backfill some of the investment highlights with financial details. To be honest I really struggled with what to put in this post. It's easy to go overboard with facts and figures, and while more information might make an investor feel comfortable it doesn't make a thesis any better. In the end I decided that I wanted to show that Hanover Foods is both safe and cheap so I'll provide the background to support those assertions. I also have a small addendum with details on how to find further information on the company.

Safe

Saying a company is safe can mean a variety of different things, safe as in strong earnings power, or safe as in a rock solid balance sheet? I really like David Merkel's analogy of stability as a bike vs a table. What's unique about Hanover is are have both, they have the bicycle stability (earnings) and table stability (balance sheet). If the company keeps moving forward their earnings provide stability, and if all earnings stop their balance sheet provides a backstop.

Balance Sheet

I first want to discuss the balance sheet stability that Hanover Foods exhibits. I mentioned in my last post they're selling below liquidation value. Of course whenever I roll out a comment like this I feel the obligation to post my liquidation worksheet as well:

The two most important values on this worksheet are the Net Current Asset Value and the NCAV + Fixed Assets. NCAV is a rough approximation for liquidation value. In the case of Hanover Foods if they liquidated today it's plausible a shareholder would receive $102.57 a share, that's a good $10-20 higher than the current share price.

The second value is what I would consider a tangible book value for Hanover Foods. I exclude goodwill, prepaid expenses, intangibles, and other assets. When looking at earnings these intangibles are important because they could be things that drive the business such as the brand, or franchise value. When looking at the balance sheet and trying to descern the safety of an investment I'm more concerned about the tangible downside.

In both cases, liquidation value, and tangible book the value is much higher than the current share price. Of note is that tangible book is almost double NCAV which accounts for the large manufacturing operation Hanover runs.

If we add back in all the intangibles and goodwill to my tangible book value the result is $252 a share, which is the same as shareholder's equity on the balance sheet.

In summary from an asset value perspective Hanover has a value of somewhere between $102.57 and $252 a share.

Earnings

The second aspect of Hanover Food's safety is the stability of their earnings power over the past few years. I only have the past few years courtesy of a reader who's been a shareholder as long. What I'm missing is the gap of data between 2004 and 2008, a period of four years.

I'm sure after looking at the spreadsheet readers will be questioning my phrase "stability of their earnings power". Revenue has been somewhat stable for the past few years, consistent would probably be a better word. The question is why did the company earn $20.80 on $379m in revenue and only $16.26 on $425m in revenue this past year? The answer can be found in the line item "Selling Expenses". Cost of goods sold and administrative expenses have remained steady but selling expenses have been gliding upwards.

Selling expenses in the frozen food industry means grocery store promotions and advertising. Hanover is having to offer more and more coupons and spend more on advertising to get consumers to part with their money. I love anecdotes so I'll throw in my two cents, my wife has seen an uptick in Hanover coupons in the Sunday paper these past few years. This could be the company trying to keep up with the couponing fad, or a response to changing consumer habits from the recession. I don't know if this is a permanent shift, or something that might be reduced once the consumer is back to their normal spending habits. What I do know is that this is the sort of piece of information that investors will dwell on, and in the end it doesn't make a huge different in the thesis.

From an earnings stability standpoint Hanover Foods has been generating earnings in the 3-4% net income range for the past four years which included the recession. The earnings of $16-26 a share isn't insignificant when considering their shares trade at $80(A)-90(B) a share.

Cheap

I don't know what an exact intrinsic value for Hanover is, and I doubt anyone really does. I'm willing to bet if you got John Warehime on the phone this afternoon and asked him for the exact fair market value of his company he'd probably balk and then give a range. I'm going to do the same, provide a range of plausible values for Hanover Foods with supporting evidence, none of which is a discount cash flow analysis.

The absolute lowest value that Hanover should be worth is their liquidation value which I mentioned above at $102.57. If we continue to look at them on an asset basis we get $209 as tangible book value and $252 as book value. For a stable company I would be surprised if in an acquisition scenario they went for less than book value, but stranger things have happened.

The second worst case scenario I'd consider is what the company paid for shares back in 2004 when they went dark. At the time they had an appraisal done which pegged fair value at $131 for the A shares, and $138 for the B shares. Since then the company has grown at about 8% a year, so it would be crazy to think it's now somehow worth less than it was in 2004.

Another data point to consider is what the company itself thinks shares might be worth. In their 2011 annual report they state they have a standing offer to buy back 6811 shares of their class A stock for $1,027,000. This comes out to $150.78 a share.

Finally the last data point is what the company's own earnings power supports. Using a 10x multiplier on the last year of data we get $162 a share. Using a 10x multiplier on the average earnings for the last four years we're sitting at $211/sh. I think a P/E of 10x is reasonable although something closer to 12x might be more appropriate. At 12x with the same figures as above we get a range of $192/sh to $253/sh.

With these four methods we get a range from $102 all the way to $250 a share, and remember you can buy the A shares today for $82. I think a more accurate range is from $150-250 a share, more than double today's quote. It's probably possible to pick up B shares in the $80/sh range as well if you use a limit order and are patient.

I built out a small table summarizing the range of values:

Where to find more information on Hanover

After my last post I received a lot of emails and comments asking where I was getting my information from on Hanover since they haven't filed with the SEC since 2004. Hanover has gone dark which means they no longer publicly file. They do still distribute an audited annual report along with quarterly reports to shareholders each year. This was on provision the board of directors insisted on as part of the going dark transaction, and the company has followed through the last eight years.

To get a copy of the annual report an investor needs to buy one share or more of the company, either the A or B shares. Once they own the share they can call Hanover and request a copy of the latest annual report. All shareholders will receive the quarterly and annual reports automatically once they own a share and as long as they hold.

The first issue a shareholder will face is getting the reports, the second is trying to figure out the shares outstanding. There are preferred shares, class A shares (non-voting) and class B shares (voting). What convolutes this is there is also an Employee Stock Ownership Trust (ESOT), and an Employee Stock Ownership Plan (ESOP). The ESOP owns B shares that have been issued, so the ESOP's shares can be subtracted from the total outstanding. The ESOT is a lot dicier and more confusing. I have read a lot of documentation on this and the conclusion is to subtract out the ESOT shares as well. There are court filings that support this presumption along with company statements as well. The number of shares outstanding I ended up with was 754,000. I've talked with a few other Hanover investors and we all ended up in the 750,000 range give or take a few thousand shares.

Summary

Hanover Foods is what I expected to find when I started looking through unlisted companies. I was looking for decent companies that were selling at unreasonable valuations due to the difficulty in obtaining information. Hanover Foods surely fits that description. For an investor buying an A share today the company is earning $16 on your investment of $82 or a 19.5% investor return. Even the B shares which are a bit pricier offer about a 17% investor return. This return assumes the company continues to grow at the same pace they have in the past and the share value stays depressed. Of course as I laid out above I think that Hanover Foods provides a nice compounding return, but more so they provide the opportunity to benefit as the shares rise into the fair value range, at double todays trading price.

I wanted to write a follow up to my post on CIBL from January. The original post is linked here. I don't follow up on too many of my ideas because so far not that many ideas have played out in a way that deserves a post. The CIBL thesis has played out, and there's still a lot of interest in that post, so instead of having people wade through comments to find answers I thought I'd post an update.

CIBL was originally a spinoff of assets from the communications company LICT (written up here). The assets CIBL holds are partnership interests in two wireless companies in New Mexico as well as an interest in two TV stations located in Iowa.

What made CIBL interesting was that management had indicated that they believed their wireless assets were worth more than the trading value of the shares and they intended to sell them if possible. When I first posted I received a number of comments from burned out shareholders telling me that management had been trotting out that line for a while and they doubted a sale would happen. I'm happy to say they were wrong and a sale is finally pending.

What happened

On March 23 news hit the wire that CIBL had reached an agreement to sell their wireless partnerships. The long awaited asset monetization had finally come to pass. Now all shareholders had to do was wait for the proxy which outlined the deal. The proxy was posted either late last night or early this morning and can be found here.

In my post on CIBL I had estimated that a range for the wireless assets was anywhere from $25m to $68m, a very large range. Based on the limited details I had on the wireless it was really hard to nail something down more accurate then that. The good news was at the time there was a large margin of safety, the company was selling for $15m which included both the wireless and the TV stations. There was a lot of discussion on the original post on what a proper buyout multiple might be. As it turns out Verizon ended up paying 7.5x the partnership EBIT and 12x the partnership cash distributions. Here is the table included in the proxy showing the partnership EBIT and distributions:

According to the proxy CIBL sold their partnership interests to Verizon Wireless for $31m which is in the lower end of my range, but still double the market cap at the time of the post. CIBL estimates that the after tax proceeds from the sale will be $18,775,000 which comes out to $750 per share.

Of note as well is the process, CIBL was first approached by Verizon in 2008 and was made an offer that CIBL considered too low. The companies went back and forth for the next four years and finally this winter agreed on the $31m price. The proxy states that this offer is 75% higher than the original Verizon offer. Verizon was and is the only interested buyer, so if CIBL shareholders vote this down it's unlikely someone else will come in with a higher offer.

Going forward

I think the estimate of value for the TV stations is probably unchanged at around $200 a share. The company also has about $75 per share in cash at the end of 2011. The company stated multiple potential uses for the cash in the proxy, here's what they said:

The company doesn't indicate if they have had any interest in selling the TV stations. So if CIBL paid out the entire $750 as a dividend shareholders would be left with $75 in cash and two TV stations that might be worth $200 or so.

When I thought about this I came to the conclusion that I'd rather have $950 today if possible rather than wait for a the stations to be sold off and proceeds distributed. So I sold out of my shares this morning at $950. The end result was a 50% gain in three months which I'm happy about, but it wasn't the double or triple I was hoping for.

Lessons learned

I felt like there were a few take aways from my short investment (2.5 months!) in CIBL.

A precise intrinsic value calculation isn't necessary if you can buy with a big enough margin of safety. My range of $25-68m was large, but I purchased CIBL at $15m. The sale took place in my range guaranteeing me a gain.

Even illiquid unlisted stocks become fully valued eventually. A shareholder who purchased based on managements original comments has between a 4.5x and 6x gain on their purchase.

I was overly optimistic on my original assessment because I didn't understand some of the nuances of the partnerships. I read the filings but didn't totally understand exactly how the partnership breakdowns worked. This meant in my original assessment I attributed much more of a potential sale to CIBL then what would eventually go to them. This could have been a much bigger error, but again having a wide margin of safety saved me.

Before I start I want to thank a reader who has sent me a lot of valuable information that made this post possible. I'd seen Hanover Foods in the Walkers Manual, but without some of the documents emailed to me I'd have likely passed over it.

Sometimes a company carries a stereotype, a company that makes products we use daily might be considered high quality, a medical device company is viewed as good, while a cigarette company has a bad label. Hanover Foods is no different they carry with them a number of stereotypes, unlisted company, and controlled by a founding family, and hard to understand. All of these stereotypes turn off potential investors, but I think once one looks past them there's a lot of value to be uncovered.

Why Hanover?

After reading the intro the your first thought is probably: "Are they even worth investing in?" The investment case for Hanover Foods is simple and laid out at a summary level below.

First off the company went dark in 2004 paying shareholders $131/share for their A shares, at the time the A shares were trading in the same range they are now ($80/sh range), a considerable premium. During the going private transaction a valuation was completed which pegged the fair market value of the A shares at $131 and the B shares at $138. At the time of going dark the book value of Hanover Foods was $99/sh. Fast forward to today:

Earned $16.24/sh in 2011 has a current P/E of 5

Grew book value from $137/sh in 2004 to $250/sh in 2011

Liquidation value of $99.39/sh

The company has an outstanding offer to buy employee owned shares purchased before 1988 at $150/sh.

$37.89/sh of cash from operations for a P/CF of 2.16

FCF of $23.79/sh for a P/FCF of 3.44

EV/EBIT of 4.45 and EV/FCF of 4.59

What is Hanover Foods?

I don't think an investor can understand why Hanover Foods is a good investment without understanding what they do and some of their history. The history is critical to this investment.

Hanover Foods was founded as a local vegetable canning company in eastern Pennsylvania by Harry Warehime in 1924. In the early 1950s Hanover expanded from canning into selling quick frozen vegetables. In 1955 Harry's son Alan took over as President and CEO expanding the company into snack foods and growing Hanover into a fully integrated food manufacturer. The company purchased a Guatemalan food producer allowing Hanover to grow their own vegetables year round.

In 1990 the grandson of Harry Warehime, John took over as CEO of Hanover Foods. The way Alan controlled the Hanover company was through a voting trust which owned a large amount of B shares. On Alan's death control of the trust was passed to John. The beneficiaries of the trust were Alan's three children and five grandchildren, but only John was able to vote the shares.

In the years following Alan's death Hanover continued to grow as a business and experience turmoil at the top. Michael Warehime and John became entangled in a number of legal battles for control over the voting trust. There is a considerable amount of documentation out there if anyone wants to read about this at a more detailed level. Hanover's old SEC filings (reference page 10) touch on the court cases.

So to sum things up, Hanover Foods is owned by the Warehime family but controlled by John. The family can't even agree on control and at times in the past have fought over board seats. A court document I read stated that in 1998 Alan's children hadn't talked to each other in over three years, and given the subsequent court battles I'm guessing this hasn't changed.

The issue with a family held company is an outside investor needs to trust that management will do the right thing, if they don't there's a possible investment loss. The court battles are troubling, and really put a taint on the owning family. I don't really know much else about the litigation or family struggles beyond what was in some old annual reports and court documents. It's unclear if there were some old skeletons driving the lawsuits, or if it was simply a battle for control.

If you take a step back and look at John Warehime's tenure at Hanover from a strictly pragmatic view he's done quite well as a manager. As mentioned above equity has grown quite nicely over the years. The company has been consistently paying down debt while steadily acquiring complimentary food companies over the years.

The biggest question mark with regards to Hanover and the family is who takes over for John? John Warehime is currently 75 and it's unclear how long he'll continue in the CEO role. His three children are all listed in the annual report as being on the board of directors, with the same title "Assistant to the Chairman". My presumption would be one of his children takes over, which could be a catalyst for some sort of change in ownership structure or dividend.

The Products

Hanover Foods grows, packages and distributes a wide variety of frozen vegetables, snack foods, and other ready to heat and eat types of foods. As part of my research into Hanover I went down to the local grocery store to browse the coolers. In this grocery they had three coolers full of frozen veggies, 1/3 a private label brand (could be Hanover?), 1/3 Hanover and 1/3 Birds Eye. My wife claims Birds Eye is a premium brand, I wouldn't know, I can't really tell the difference between them. The Hanover items were on sale but the sale price was still slightly higher than the generic brand they sat next to. Interestingly enough the Hanover items had sold very well compared to the generic (lack of inventory). So people were purchasing their products even though they could get a generic frozen vegetable for a few dimes less.

I didn't end up buying any Hanover frozen veggies which might seem strange, but we have them all the time here along with the occasional Troyer bag of chips. When I browed the Hanover website I felt that I could confidently say I'd probably eaten 40-50% of their products.

Other cheap factors

The two other factors I listed that I feel are the cause of Hanover's cheapness are the fact that the shares are unlisted, and secondly some aspects of the company are hard to understand.

I will touch on some of the difficult to understand items in another post, but want to quickly address the unlisted status. Hanover went dark giving the reasoning that they wanted to save filing fees and compliance costs. This was popular back in the early to mid 2000s but seems to have trailed off.

A lot of companies that have gone dark are small companies, Hanover isn't that tiny, they have a market cap of $61m at current prices and sales of $425m. The company distributes quarterly reports to shareholders as well as an annual report. The reports aren't much more than the current financial statements, but the statements are very robust compared to some of the dark companies I've looked at.

Next..

I'm going to do another post on Hanover looking at some of the financial aspects of the company in support of the bullet points I posted at the top of this post. I want to examine the financials for completeness sake, but at this point if Hanover doesn't look like a good investment to you seeing a bunch of facts and figures probably isn't going to change your mind. I'm hoping to have a follow up post in the next week or so.

I've mentioned in a previous post that I went through a list of 100 Japanese net-net stocks and scored them which resulted in 33 stocks that I want to research further. For the most part I will be reviewing the stocks in batches of three or four stocks at a time. This means there will be close to ten more posts about Japanese net-net's mixed throughout other posts in the future unless I see that no one's reading them. If the posts about Japanese net-net's suddenly disappear it's not because I've lost interest, it's because you the readers have no interest.

One of the commonly asked questions I get when I post about Japanese stocks is how does someone go about purchasing them? Some readers might not feel comfortable trading directly in Japan, so I did a search of all ADRs from Japan and tried to match the ADR names to my research further list, one company matched. For readers that are interested I have included in this post information at the bottom about trading directly in Japan.

Tsutsumi Jewelry is Japan's largest importer of diamonds from India and runs a very developed stone trading network worldwide. The company claims the volume of stones they move gives them a cost advantage over competitors. Once the precious stones are imported Tsutsumi Jewelry manufactures jewelry and then sell it via their network of company owned retail stores or online. The company operates 179 stores across Japan. The blurb describing their stores says they're comfortable and hospitable making customers at ease to come and go as they please. It sounds really nice but from the picture it just looks like a mall jewelry store, nothing fancy.

The company has a nice website where you can browse jewelry and order online. The products looked nice, I have no idea if the prices were reasonable or not. I also have no taste in jewelry and my wife wasn't interested in browsing the website so I have no real opinion on the quality of this stuff.

The real attraction of Tsutsumi Jewelry is that they're a consistently profitable company with substantial free cash flow selling for less than their liquidation value. Here is a snapshot of their net-net value:

The company is currently selling for almost exactly the discounted net-net value. This means if you purchased today and the stock merely rose to NCAV you'd have a 23% gain. If you purchased and decided to sell when the stock reached an adjusted book valued (NCAV + PPE) you would lock in a 51% gain.

The company isn't losing money or bleeding cash, they actually have a decent net margin and return on equity meaning they should at least trade at book value. Here are some other investment highlights:

-Five year EV/CF 3.75x
-Five year EV/FCF of 4.42x
-ROE ex-cash of 4.89%
-Net margin of 8.89%
-1.14% dividend yield
-A large portion of their market cap is in cash.

When I look at a net-net I want to have a margin of safety and cash flow that is supporting my margin of safety. In the case of Tsutsumi Jewelry the company has both, a significant discount to liquidation value and stable cash flows for the past five years. Capital expenditures have been steady and low, about 10% of CFO. The rest of the cash goes towards dividends and to the bank.

Here's how Tsutsumi Jewelry compares with the other Japanese net-net's I've researched:

Researching further

For an investor looking to buy a Japanese net-net stock Tsutsumi Jewlery is really a perfect one to get started with. The company offers an English version of their website here.

The company also offers quarterly financial statements in English published here.

Lastly MSN Money has great data on Japanese stocks, here is the page for Tsutsumi Jewelry.

Final thoughts

I think Tsutsumi Jewelry is a pretty high quality Japanese net-net. For someone just starting out building a Japanese net-net portfolio this would be a perfect stock to add. The company has a large English language website, and has English filings giving an investor an extra layer of comfort. I haven't purchased any shares yet because I haven't finished my project of profiling my 33 selected net-nets. Once I'm done if Tsutsumi stands out I might end up purchasing shares. I think there are a lot worse stocks an investor could buy, Tsutsumi Jewlery seems like a pretty safe bet.

Trading Japanese stocks as an American

There are three brokers in the US that allow trading of Japanese stocks, I have them listed and the markets they trade on below.

ETrade - (Tokyo Exchange Only) Of the American brokers ETrade is the most at ¥3399 per trade.Interactive Brokers - (Tokyo Exchange Only) The cheapest on a per trade basis. Commission depends on the trade size, but it's usually only a few dollars.Fidelity - (All Japanese exchanges, Tokyo, Osaka, JASDAQ, Nagoya) Trades cost ¥3000 per trade.

All three brokers charge a currency conversion fee based on the dollar amount you want to convert to Yen, pricing is on a sliding scale.

Trading in Japan takes place between 8pm and 2am EST. Even for illiquid stocks I have always had a fill, not right away but within a few hours.

I looked into both ETrade and Interactive Brokers and went with Fidelity as my broker. Fidelity can trade in 13 or 14 markets, ETrade only in 6. Interactive Brokers has access to a lot more markets but they penalize you with a no activity fee if you don't trade a certain amount of times per month. I'll sometimes go months with no trades and didn't like the idea of paying for my inactivity.

Interested in trading in Japan in general? I highly recommend Steven Town's book Investing in Japan that I reviewed here.

I want to thank a reader who's an avid pink sheet investor for sending me some information on this stock along with a few others. The information sent was invaluable.

Hershey Creamery is a ice cream manufacturer and distributer located in Harrisburg Pennsylvania. They've been in business since 1894 and were started by the Hershey brothers. Hershey Creamery is a completely separate company and has no relation to Hershey the candy company located in Hershey PA which is just down the road from Harrisburg.

Hershey Creamery manufacturers both ice cream, ice cream novelties, smoothies, and ice cream coffee drinks. The company has an interesting distribution arrangement, they don't distribute to common grocery stores but rather distribute to stores where they can be the dominant ice cream product. This means if you're at a Giant Eagle you won't find Hershey Ice Cream, but if you're at MacBeth's Gift Shop in Cooksburg PA you'll find the freezer stocked full (I speak from experience regarding MacBeths).

I've had Hershey Ice Cream in the past, but wanted to try it again before doing this post. Unfortunately the place that sells it near my house has either closed for good or hasn't opened for the season yet. We ended up getting some ice cream at a local place down the road which was awesome, but is a moot point in researching for this post.

The company has been run by the Holder family since the 1920s. George Hughes Holder was the President and Chairman until he passed away in 2009. The company is now run by his three sons.

Why is the company interesting?

Hershey Creamery is a typical unlisted company, they run like a private company but have shares that seem to trade on an ad-hoc basis. The last time Hershey Creamery shares traded was January 23rd, when six shares traded hands. The company has 96,066 shares outstanding but most reside as treasury stock, there are only 35,359 outstanding, and the majority of those are held by the Holder family.

Here are a few interesting items regarding the company:

Hershey Ice Cream is sold in 28 states.

The company operates 22 distribution centers.

They're still headquartered in the same place as where they started in the 1800s.

In 2010 they had $94m in sales, $4m in operating income and $3.7m in net income.

EPS of $105.92 and a dividend of $16.80/sh

The company has a $61.8m market cap

Enterprise value of $15m if you include their portfolio of marketable securities (stocks, and cash)

EV/EBIT of 3.77

EV/FCF of 11.8

ROE 4.12%

ROE ex-cash of 8.48%

Here is the net-net worksheet:

What's it worth?

Hershey Creamery isn't a stellar business but they're pretty steady. If you take into account the overcapitalization they're probably close to fairly valued currently. On a cash plus operating business basis I can see maybe $2000 being a fair value, and $1750 isn't that far off, especially in the pink sheet world.

Some people might argue that the company should trade at book value which would mean the company would be worth around $2565 a share.

The reality though is Hershey will probably trade where it's at unless either earnings explode (unlikely especially with high fuel costs) or if the company is bought out. A buyout is the most likely way any value is going to be realized for a shareholder of Hershey Creamery.

I was able to get some stats on ice cream company buyouts over the years from Adam at ValueUncovered (big thanks!) and put together a spreadsheet showing what that might mean for Hershey Creamery. I used price to sales because this was the most consistent ratio I could find in the dataset.

So going through the buyout data we get a range of possible values for Hershey going from $3706 a share to $10339 a share. All significantly higher than what it trades at today, but all betting that the family that has run Hershey Creamery since 1920 decides to sell.

While there's significant upside for a shareholder if Hershey Creamery is sold I'm not optimistic that the company will actually be sold in the near future. George Hughes Holder's sons seem intent on running the business the same way as their father did including keeping a large hoard of cash and paying out a paltry dividend. If the company increased their payout, or something changed leading me to believe the sons were going to sell I would become very interested in Hershey Creamery, until then I'm content to watch them from the sidelines.